Dell Reports Mediocre Q2

Dell Inc. (DELL) delivered earnings of 50 cents per share in the second quarter of 2013, exceeding the Zacks Consensus Estimate of 45 cents. Following the earnings release, the company’s share price dropped in extended U.S. trading and has lost 16.0% this year, as the company witnessed declines in revenue across all of its business segments and most of its geographical regions.

Revenues

Dell reported total revenue of $14.5 billion in the reported quarter, down 7.5% from the year-ago quarter. The lower revenue resulted from revenue declines across all business segments.

Revenue by Segments

Large Enterprise posted revenue of $4.54 billion, down 3.0% year over year. The decline in revenue was driven by lower business activity in the developed markets, resulting in the overall revenue decline. The pipeline of new orders is decent, but the customers are delaying their spending on new IT products. Moreover, the company’s PC business growth is facing challenges, as it witnessed a tough macroeconomic and competitive environment, and continues to focus on higher-value solutions in this business

Public Revenue was $4.07 billion, down 6.0% year over year. The company did not witness the typical seasonal benefits in the state and local government businesses in the U.S. The softness was driven by continued budgetary challenges.

Small and Medium Business revenue was down 1.0% to $3.26 billion. Within the SMB segment the company witnessed strong Enterprise Storage & Servers (ES&S) growth of 15%, which includes a 27% growth in services, but was offset to a considerable extent by a contraction in the European business.

Consumer Business revenue crashed 22.0% to $2.62 billion, with notebook revenue down 26%. Although, the company held market shares in key mature markets like the U.S., but the emerging markets offered stiff competition and primarily the low-end products registered growth.

Operating Results

Gross margin in the reported quarter declined to 21.6% from 22.5% in the year-ago quarter. Gross margin for the quarter was negatively impacted by the higher drop in revenue as compared to the decline in total operating expense.

Operating income for the quarter was $901.0 million or 6.2% of revenues in the reported quarter, down 21.0% year over year. The company was not able to control its expenses properly. Also, lower revenues resulted in the decline in operating income.

GAAP earnings in the quarter were 42 cents per share compared with 48 cents a share in the year-ago quarter. Excluding special items like amortization of intangibles, severance and facility consolidation cost, acquisition-related costs, as well as income tax adjustments, earnings per share in the quarter were 50 cents versus 54 cents in the year-ago quarter.

Balance Sheet & Cash Flow

Dell’s cash conversion cycle deteriorated by 2 days compared with the previous quarter to negative 30 days, primarily driven by an increase in DSO of 3 days. This increase in DSO can be attributed to the shift in mix to more complex ES&S opportunities, where customer terms are typically longer.

Guidance

The company expects third quarter revenue to be down 2.0% to 5.0% sequentially. Apart from this, considering the uncertain environment and competitive dynamics, management lowered fiscal 2013 EPS outlook to $1.70 per share. This includes a 2-3 cents dilutive impact from the pending acquisition of Quest Software.

Recommendation

Dell reported mediocre second quarter results. EPS exceeded the Zacks Consensus Estimate, but both revenue and earnings per share declined on a year-over-year basis. Also, the quarterly revenue failed to counter the effect of contraction in personal computer sales.

The company witnessed a decline in revenue from every business segment, as the company experienced low business activity in developed markets. Opportunities in the Electronic Medical Record sector, increased focus on cloud computing are positives for the company, but pickup in demand would take some time, as the IT spending pattern of companies doesn’t look that promising.

Thus, we have a Zacks #4 Rank, implying a short-term Sell rating.